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Investment Strategy

Looking for a Pullback

By Elliott H. Gue, on Apr. 30, 2015

The S&P 500 has traded in a tight range since mid-February and has treaded water since late November.

The risk of a 5 percent to 10 percent pullback in the S&P 500 continues to rise. Although the market remains placid on the surface, quarterly earnings have been weak, and the US economy has shown signs of softness.

About half the companies in the S&P 500 have reported first-quarter results; roughly 75 percent delivered positive earnings surprises—on par with the fourth quarter of 2014.

However, top-line results have been less encouraging, with only 48.1 percent of the S&P 500 companies that have reported earnings beating the Bloomberg consensus sales estimate. In the first quarter of 2014, 56 percent of the S&P 500 posted revenue that topped analysts’ expectations.

Whereas companies can bolster their earnings per share by buying back stock or cutting costs, revenue growth offers better insight into actual demand and potential growth.

Recent top-line weakness in the S&P 500 primarily reflects two interrelated factors: a strengthening US dollar and softness in the US economy. Uncle Buck’s rally since last summer made US-produced goods more expensive in international markets and reduced the value of foreign revenue upon repatriation.

A strong greenback has a more pronounced effect on the large-capitalization multinationals that dominate the S&P 500. In contrast, small-cap stocks, many of which generate the bulk of their revenue in the US, have outperformed in 2015; the Russell 2000 Index has generated a total return of 4.9 percent, compared with the S&P 500’s 3.2 percent gain.

(Click graph to enlarge.)SPX vs RTY

More worrisome is the divergence between the S&P 500, which continues to hover around its all-time high, and the deterioration in US economic data that has occurred since last summer.

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